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Advanced corporate finance mid-term prep quiz questions

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FINC 5880 Mid-Term

Question 1 of 48

1

As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.

Select one of the following:

  • True
  • False

Explanation

Question 2 of 48

1

Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital. Consequently, the firm should make arrangements with its suppliers to use as much of this credit as possible.

Select one of the following:

  • True
  • False

Explanation

Question 3 of 48

1

A firm will use spontaneous funds to the extent possible; however, due to credit terms, contracts with workers, and tax laws there is little flexibility in their usage.

Select one of the following:

  • True
  • False

Explanation

Question 4 of 48

1

As long as a firm does not pay out 100% of its earnings, the firm's annual profit that is retained in the business (i.e., the addition to retained earnings) is another source of funds for a firm's expansion.

Select one of the following:

  • True
  • False

Explanation

Question 5 of 48

1

A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset.

Select one of the following:

  • True
  • False

Explanation

Question 6 of 48

1

A firm's AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.

Select one of the following:

  • True
  • False

Explanation

Question 7 of 48

1

If a finn wants to maintain its ratios at their existing levels, then if it has a positive sales growth rate of any amount, it will require some amount of external funding.

Select one of the following:

  • True
  • False

Explanation

Question 8 of 48

1

To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities$, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.

Select one of the following:

  • True
  • False

Explanation

Question 9 of 48

1

The capital intensity ratio is the amount of assets required per dollar of sales and it has a major impact on a firm's capital requirements.

Select one of the following:

  • True
  • False

Explanation

Question 10 of 48

1

One of the first steps in arriving at a firm's forecasted financial statements is a review of industry-average operating ratios relative to these same ratios for the firm to determine whether changes to the ratios need to be made.

Select one of the following:

  • True
  • False

Explanation

Question 11 of 48

1

Operating plans sketch out broad approaches for realization of the firm's strategic vision. These plans usually are developed for a period no longer than a I-year time horizon because detail is "lost" by extending out the time horizon by more than 1 year.

Select one of the following:

  • True
  • False

Explanation

Question 12 of 48

1

One of the necessary steps in the financial planning process is a forecast of financial statements under each alternative version of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.

Select one of the following:

  • True
  • False

Explanation

Question 13 of 48

1

If a firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100%, and if it wants to hold all financial ratios constant, then for any positive growth rate in sales, it will require external financing.

Select one of the following:

  • True
  • False

Explanation

Question 14 of 48

1

A firm's profit margin is 5%, its debt/assets ratio is 56%, and its dividend payout ratio is 40%. If the firm is operating at less than full capacity, then sales could increase to some extent without the need for external funds, but if it is operating at full capacity with respect to all assets, including fixed assets, then any positive growth in sales will require some external financing.

Select one of the following:

  • True
  • False

Explanation

Question 15 of 48

1

Companies with relatively high assets-to-sales ratios require a relatively large amount of new assets for any given increase in sales; hence, they have a greater need for external financing. There are currently no alternatives for these types of firms to lower their asset requirements.

Select one of the following:

  • True
  • False

Explanation

Question 16 of 48

1

Firms with high capital intensity ratios have found ways to lower this ratio permitting them to achieve a given level of growth with fewer assets and consequently less external capital. For example, just-in-time inventory systems, multiple shifts for labor, and outsourcing production are all feasible ways for firms to reduce their capital intensity ratios.

Select one of the following:

  • True
  • False

Explanation

Question 17 of 48

1

Two firms with identical capital intensity ratios are generating the same amount of sales. However, Firm A is operating at full capacity,. while Firm Bis- operating below capacity. If the two firms expect tile same growth in sales during the next period, then Firm A is likely to need more additional funds than Firm B, other things held constant.

Select one of the following:

  • True
  • False

Explanation

Question 18 of 48

1

If a firm's capital intensity ratio (A0*/S0) decreases as sales increase, use of the AFN formula is likely to understate the amount of additional funds required, other things held constant.

Select one of the following:

  • True
  • False

Explanation

Question 19 of 48

1

The minimum growth rate that a firm can achieve with no access to external capital is called the firm's sustainable growth rate. It can be calculated by using the AFN equation with AFN equal to zero and solving for g.

Select one of the following:

  • True
  • False

Explanation

Question 20 of 48

1

The fact that long-term debt and common stock are raised infrequently and in large amounts lessens the need for the firm to forecast those accounts on a continual basis.

Select one of the following:

  • True
  • False

Explanation

Question 21 of 48

1

Which of the following statements is correct?

Select one of the following:

  • If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase.

  • The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model.

  • Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk.

  • A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs.

  • The tax code encourages companies to pay dividends rather than retain earnings.

Explanation

Question 22 of 48

1

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that

Select one of the following:

  • investors require that the dividend yield and capital gains yield equal a constant.

  • capital gains are taxed at a higher rate than dividends.

  • investors view dividends as being less risky than potential future capital gains.

  • investors value a dollar of expected capital gains more highly than a dollar of expected dividends because of the lower tax rate on capital gains.

  • investors are indifferent between dividends and capital gains.

Explanation

Question 23 of 48

1

Which of the following should not influence a firm's dividend policy decision?

Select one of the following:

  • A strong preference by most shareholders for current cash income versus capital gains.

  • Constraints imposed by the firm's bond indenture.

  • The fact that much of the firm's equipment has been leased rather than bought and owned

  • The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.

  • The firm's ability to accelerate or delay investment projects.

Explanation

Question 24 of 48

1

Which of the following statements about dividend policies is correct?

Select one of the following:

  • One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases.

  • One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest.

  • One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.

  • The clientele effect suggests that companies should follow a stable dividend policy.

  • Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the "bird-in-the hand" effect.

Explanation

Question 25 of 48

1

Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?

Select one of the following:

  • Its access to the capital markets increases.

  • Its R&D efforts pay off, and it now has more high-return investment opportunities.

  • Its accounts receivable decrease due to a change in its credit policy.

  • Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.

  • Its earnings become more stable.

Explanation

Question 26 of 48

1

An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

Select one of the following:

  • True
  • False

Explanation

Question 27 of 48

1

The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.

Select one of the following:

  • True
  • False

Explanation

Question 28 of 48

1

The exercise value is the positive difference between the current price of the stock and the call option’s strike price. The exercise value is zero if the stock's price is below the strike price

Select one of the following:

  • True
  • False

Explanation

Question 29 of 48

1

The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

Select one of the following:

  • True
  • False

Explanation

Question 30 of 48

1

As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased.

Select one of the following:

  • True
  • False

Explanation

Question 31 of 48

1

If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

Select one of the following:

  • True
  • False

Explanation

Question 32 of 48

1

If the market is in equilibrium, then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.

Select one of the following:

  • True
  • False

Explanation

Question 33 of 48

1

Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.

Select one of the following:

  • True
  • False

Explanation

Question 34 of 48

1

Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.

Select one of the following:

  • True
  • False

Explanation

Question 35 of 48

1

If we define the "premium" on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock's current market price and the strike price), then we would expect the premium to increase as the stock price increases, other things held constant.

Select one of the following:

  • True
  • False

Explanation

Question 36 of 48

1

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock, provided the strike prices for the put and call are the same.

Select one of the following:

  • True
  • False

Explanation

Question 37 of 48

1

If a company announces a change in its dividend policy from a zero target payout ratio to a 100% payout policy, this action could be expected to increase the value of long-term options (say 5-year options) on the firm's stock.

Select one of the following:

  • True
  • False

Explanation

Question 38 of 48

1

An option that gives the holder the right to sell a stock at a specified price at some future time is

Select one of the following:

  • a put option.

  • an out-of-the-money option.

  • a naked option.

  • a covered option.

  • a call option.

Explanation

Question 39 of 48

1

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

Select one of the following:

  • Variability of the stock price.

  • Option's time to maturity.

  • Strike price.

  • All of the above.

  • None of the above.

Explanation

Question 40 of 48

1

Which of the following statements is most correct, holding other things constant, for XYZ Corporation's traded call options?

Select one of the following:

  • The higher the strike price on XYZ's options, the higher the option's price will be.

  • Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months.

  • If XYZ's stock price stabilizes (becomes less volatile), then the price of its options will increase.

  • If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend.

  • The price of these call options is likely to rise if XYZ's stock price rises.

Explanation

Question 41 of 48

1

BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?

Select one of the following:

  • The exercise price of the option is increased.

  • The life of the option is increased, i.e., the time until it expires is lengthened.

  • The Federal Reserve takes actions that increase the risk-free rate.

  • BLW's stock price becomes more risky (higher variance).

  • BLW's stock price suddenly increases.

Explanation

Question 42 of 48

1

Which of the following statements is CORRECT?

Select one of the following:

  • Call options give investors the right to sell a stock at a certain strike price before a specified date.

  • Options typically sell for less than their exercise value.

  • LEAPS are very short-term options that were created relatively recently and now trade in the market.

  • An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

  • Put options give investors the right to buy a stock at a certain strike price before a specified date.

Explanation

Question 43 of 48

1

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?

Select one of the following:

  • Put

  • Naked

  • Covered

  • Out-of-the-money

  • In-the-money

Explanation

Question 44 of 48

1

Cazden Motors' stock is trading at $30 a share. Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options?

Select one of the following:

  • The options with the $25 strike price will sell for less than the options with the $35 strike price.

  • The options with the $25 strike price have an exercise value greater than $5.

  • The options with the $35 strike price have an exercise value greater than $0.

  • If Cazden's stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.

  • The options with the $25 strike price will sell for $5.

Explanation

Question 45 of 48

1

Braddock Construction Co.'s stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share?

Select one of the following:

  • The price of the call option will increase by more than $2.

  • The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.

  • The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.

  • The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.

  • The price of the call option will increase by $2.

Explanation

Question 46 of 48

1

Which of the following statements is CORRECT?

Select one of the following:

  • Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.

  • Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.

  • Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.

  • Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

  • If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.

Explanation

Question 47 of 48

1

Which of the following statements is CORRECT?

Select one of the following:

  • Call options generally sell at a price less than their exercise value.

  • If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.

  • Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.

  • Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

  • If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock's price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.

Explanation

Question 48 of 48

1

Which of the following statements is CORRECT?

Select one of the following:

  • As the stock's price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.

  • Issuing options provides companies with a low cost method of raising capital.

  • The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.

  • The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

  • An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.

Explanation

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